Will the Expiration Cycle of S&P 500 Futures Contracts Create an Opportunity?

Andy Waldock |

The commercial traders in the S&P 500 have altered their approach to the futures’ markets quarterly expiration cycle. I believe there are two primary reasons for this and they may both setup trading opportunities.

First of all, the commercial trader category typically maintains a negative bias towards the S&P 500 futures. The two primary causes are direct selling of the futures to hedge their equity positions and the second is a hedge against downside put options that have been sold. The short put option position requires selling of futures contracts to offset the increasingly negative delta created by during market declines.

The second move in this pattern is strong commercial buying into expiration predicated by the upside calls that have been sold to generate alpha, as opposed to protection, for their portfolios. The credit received from the selling of the call options must be paired with long futures positions to limit upside risk in a rising market.

Three out of the last four quarterly expirations have followed the pattern which has been illustrated here. Commercial momentum in the S&P 500 futures is negative while the market has been making all-time highs. Currently stagnant volume and open interest strongly suggests that small speculators and index traders are now the ones pushing the market higher. 

This sets the stage for a pre-expiration sell off as the weak hands get flushed from the highs. This will also provide the opportunity for commercial traders to cover the upside calls they’ve been selling. Finally, the predicted commercial buying into expiration could very well provide the impetus for a new leg of the rally into the summer’s trading of the September S&P 500 futures contract.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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